In “In Re: Submicron Systems Corporation,” ___ F.3d ___ (3rd Cir. 1/6/06), the Third Circuit affirmed the approval of a Bankruptcy Code Section 363 asset sale (over the objection of the Plan Administrator (the “Estate”)) to a newly formed company (“Newco”) comprised of (i) a third party (“Sunrise”), and (ii) pre-petition secured lenders (the “Lenders”), where the winning and only bid was part cash and part credit bid. The Third Circuit rejected the Estate’s argument that the sale should not have been approved because the secured debt alleged by the Lenders that formed approximately 73% of the purchase price (the cash component was only approximately 27%) should have been (i) recharacterized as equity, (ii) deemed unsecured, or (iii) equitably subordinated.
In addressing recharacterization, the Court first recognized, consistent with the Sixth and Ninth Circuits, and contrary to the Fifth and Eleventh Circuits, that the inquiry is factual rather than legal (and therefore, the lower court’s ruling is reviewed for abuse of discretion rather than de novo). Applying the “abuse of discretion” standard, the Court concluded that the lower court’s finding that the debt was truly debt, and not intended as equity, was not clearly erroneous. With respect to whether the debt was secured, the Court rejected the argument that the security interest was not properly perfected because only the collateral agent (and not all of the Lenders) were listed on the financing statement as the secured party. The Court also concluded that under Bankruptcy Code Section 363(k), Newco could credit bid the full value of the Lenders’ claim, irrespective of the value of the collateral, recognizing that “to cap credit bids at the economic value of the underlying collateral is theoretically nonsensical” since the economic value of the collateral is at least what a secured lender credit bids. With respect to equitable subordination, the Court concluded that creditors were not harmed when the Lenders obtained their security interests (which had occurred in several fundings) because if the various loans had not been made, at each time a loan was made, the debtor would have been required to liquidate, leaving creditors with no recovery. The Court did not find probative that a majority of the members of the debtor’s board were agents of the Lenders, concluding that the Lenders’ board members did not “control” the board. Based on the foregoing, the Court affirmed the approval of the sale.
The Estate apparently did not argue that the sale could be avoided under Bankruptcy Code Section 363(n) because the “sale price was controlled by an agreement among potential bidders at such sale”. The limited facts set forth in the opinion at least suggest that Sunrise and the Lenders might have been willing to bid separately for the assets, and that by forming Newco and bidding together, they controlled the sale price. For example, the Court indicated that “[The Lenders], not [Debtor’s] management, conducted negotiations with Sunrise, developing and agreeing on the terms and financial structure of an acquisition to occur in the context of a prepackaged bankruptcy”. Thereafter, Sunrise and the Lenders formed Newco, and submitted a joint bid. Perhaps discovery might have revealed facts that would have given rise to a claim under Bankruptcy Code Section 363(n).